- 22 -
sec. 5(a), 1959-1 C.B. at 242. However, respondent argues that
the discounted cashflow method should not be used where future
income is unpredictable, as with HII, and “the results of such an
analysis provide little, perhaps no, indication of value and
should be accorded like weight.” We agree that an income-based
method, such as the discounted cashflow method, is not
particularly reliable where the subject company’s future income
is relatively unpredictable. See Wall v. Commissioner, T.C.
Memo. 2001-75; Pratt et al., Valuing Small Businesses and
Professional Practices 257 (3d ed. 1998). Petitioners agree that
HII’s sales and earnings are erratic and not readily predictable.
Given these circumstances, we are not convinced that the value
Mr. Heebink derived under the discounted cashflow method is
entitled to the weight that he gave to it. However, we believe
Mr. Heebink’s conclusions with respect to the discounted cashflow
analysis are entitled to some consideration.22
22Mr. Engstrom gave no weight to the discounted cashflow
method because small changes in certain assumptions resulted in
large changes in the value of HII shares. Indeed, Mr. Engstrom
opined that if HII’s expenses were increased or decreased by 1
percent of sales, it would result in a $67,000 per share increase
or decrease in the value of HII shares. He also opined that a 1-
percent increase in the discount rate would cause the implied
value to go down by $21,000 per share; a 1-percent decrease in
the discount rate would cause the implied value to go up by
$26,000 per share; and a combination of a decrease in expenses by
1 percent of sales and a 1-percent decrease in the discount rate
would result in the implied value to go up by about $100,000 per
share. As we explain later on, we do not agree that this
requires us to completely reject the discounted cashflow method
(continued...)
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